Tuesday, September 20, 2011

If Static Equilibrium Existed in the Real World...

If static equilibrium states existed in real world economies, then, according to Mises, socialism in the sense of the socialist calculation debate is possible:

“The static state can dispense with economic calculation. For here the same events in economic life are ever recurring; and if we assume that the first disposition of the static socialist economy follows on the basis of the final state of the competitive economy, we might at all events conceive of a socialist production system which is rationally controlled from an economic point of view.” (Mises 1990: 16).

I am amazed how large numbers of Austrians seem aware of this view by Mises. But, as Mises himself admits, such static equilibrium states are imaginary: they do not exist in the real world.

But transitioning from one equilibrium state to another is at the heart of Hayekian Austrian business cycle theory (ABCT), which is heavily influenced by neoclassical theory.

Hayek’s trade cycle theory was a static equilibrium theory, and also assumes that all markets do in fact clear (Caldwell 2004: 324), partly by glossing over the role of uncertainty and assuming perfect foresight. But severe problems with Hayek’s static equilibrium theory had already emerged in the 1930s:

“by the middle of the 1930s, problems with [Hayek’s] static equilibrium theory had become ever more evident, as questions of the role of expectations came to the fore and, and, with them, the recognition that earlier models had assumed perfect foresight” (Caldwell 2004: 224).

“Hayek’s changing assessment of the importance of equilibrium theory has some consequences for our story. The most telling of these concerns Hayek’s trade cycle theory, a paradigmatic example of equilibrium theory, one that Witt (1997, 48) describes as ‘an impressive example of allied price theoretical reasoning that may even delight a Chicago equilibrium economist.’ But, as Witt goes on to observe, if one rejects the usefulness of equilibrium analysis, then Hayek’s step-by-set story of how the cycle unfolds, one in which ‘each single stage necessarily had to be followed by the next one’ (46), can no longer be maintained. Witt concludes that Hayek’s cycle theory may well be incompatible with his later theory of spontaneous orders, a concern that others have voiced” (Caldwell 2004: 228).

9 comments:

Since somebody mentioned that Michael Emmett Brady fellow on another one of your entries, I figured I might add that he has an account on the Social Science Research Network. He has an article comparing and contrasting the approaches to uncertainty taken by F.A. Hayek and John Maynard Keynes. It could be used to your argument against ABCT and the Austrian definition of equilibrium.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1751569

P.S. Lord Keynes, is there any way I can contact you besides this blog?

I am amazed how large numbers of Austrians seem aware of this view by Mises. But, as Mises himself admits, such static equilibrium states are imaginary: they do not exist in the real world.

But transitioning from one equilibrium state to another is at the heart of Hayekian Austrian business cycle theory (ABCT), which is heavily influenced by neoclassical theory.

ABCT is heavily influenced by the marginalist revolution as co-founded (independently) by Carl Menger. This revolution then started the neoclassical movement. Menger influenced Mises. Theoretically, Austrians and neoclassicals share many ideas (since they arise from the same foundation), but the difference is that whereas neoclassicals focused on end states and static conceptions, Austrians focused more on entrepreneurs, dynamics, the price system, and the market process.

To Austrians, end states and static conceptions are but mental tools only, for Austrians to know clearly what does NOT exist in the real world market. It is like the concept of immortality when understanding human life. We use the concept of immortality as a mental tool to understand that humans are in fact mortal. It's the same thing with static states. Mises utilized the concept of static states as a mental tool to understand what the real world market actually is, which is not static.

Hayek’s trade cycle theory was a static equilibrium theory, and also assumes that all markets do in fact clear

No, Hayek's model is not a static equilibrium theory. Hayek's model is a dynamic model that, like Mises, utilizes the concept of a static state as a mental tool to understand the real world economy of constant changes. Hayek did not claim that markets do in fact clear. He argued that markets tend towards clearing, but because equilibrium is never reached, neither does clearing. But the concept of clearing to Hayek was not zero unemployment and zero idle resources. Full employment and full utilization of resources in Hayek's model is one where there is some unemployment and some idle resources, as the real world market economy goes through constant adjustment on its way towards equilibrium that is never actually reached.

partly by glossing over the role of uncertainty and assuming perfect foresight.

No, that is a straw man. Hayek's model does not require no uncertainty nor does it require perfect foresight. In fact, it is based on uncertainty and lack of perfect knowledge. It's why investors and consumers should become inter-temporally dis-coordinated in the first place. No uncertainty and perfect knowledge are in fact ANTITHETICAL to Hayek's model.

"He argued that ... because equilibrium is never reached, neither does clearing."

That is false.

“… Hayek’s starting point was a system that was in a state of ... total equilibrium. He would then show what sorts of things would have to happen for the system to fail to adjust properly (ie, fail to return to equilibrium) when it was disturbed. This approach was logically impeccable. However, to insist on starting one’s analysis with a system that is in full equilibrium when that equilibrium implies that all resources are fully utilized seemed bizarre in the midst of the Greta Depression”

“For Hayek Paretian general equilibrium was the pivot of economic theory, the centre of gravity towards which all major economic forces tended. For him the task of trade cycle theory was to show how it came about that these major forces were temporarily impeded and their effects delayed, and since the cycle was supposed to start with a boom and end with a depression, he saw in the depression the ultimate triumph of the equilibrating forces.”

"He argued that ... because equilibrium is never reached, neither does clearing."

That is false.

No, that is true.

“… Hayek’s starting point was a system that was in a state of ... total equilibrium. He would then show what sorts of things would have to happen for the system to fail to adjust properly (ie, fail to return to equilibrium) when it was disturbed. This approach was logically impeccable. However, to insist on starting one’s analysis with a system that is in full equilibrium when that equilibrium implies that all resources are fully utilized seemed bizarre in the midst of the Greta Depression”

That passage does not prove what you claimed was true above. Caldwell again misunderstands the nature of mental tools to understand the real world economy.

It is not "bizarre" to utilize the mental tool of an ERE, or static equilibrium, to understand how a market economy works, even if an economy with government intervention contains massive unemployment.

Hayek always held that in order to understand what can go wrong with a market economy, one first has to understand how it can go right. The concept of static equilibrium is a mental tool that can enable one to understand how a market economy can go right, not by implicitly presuming that a well functioning free market will have 100% employment and 100% utilization of resources, but rather by understanding that this is where a free market TENDS, but never reaches due to the real world being one of constant changes in economic data and learning among humans in the division of labor.

The price system is the best system, so far discovered, that can help move a free market economy that is disturbed for any reason, towards equilibrium that of course is never reached.

Hayek argued that the equilibrium state is never reached, but that thinking of equilibrium states is a useful, pragmatic, mental tool that can be used to understand the real world of change.

You're wrong to claim that Hayek held the equilibrium state as what a free market would actually reach. Caldwell is hopelessly confused on this point. I suggest you read Human Action by Mises, and flip to the pages on "ERE".

“For Hayek Paretian general equilibrium was the pivot of economic theory, the centre of gravity towards which all major economic forces tended.

Do you see that word "tended"? It means it is never reached.

For him the task of trade cycle theory was to show how it came about that these major forces were temporarily impeded and their effects delayed, and since the cycle was supposed to start with a boom and end with a depression, he saw in the depression the ultimate triumph of the equilibrating forces.”

Of course, just like Hayek also explained how even a pure free market would contain a positive amount of unemployment and idle resources due to changes constantly taking place, but Hayek's point was that the price system can minimize these problems, and move the economy closer to a given equilibrium, only to see the economy revolutionized again through further economic changes, preferences, technology, resources, knowledge, etc, which then generates a new equilibrium that is tended towards, and so on.

The ERE is a mental tool only. It is NOT an analogy, or metaphor, or characterization of the free market economy in the real world. It is a mental tool that is used to understand the real world economy.

"But the concept of clearing to Hayek was not zero unemployment and zero idle resources. "

Hayek's starting assumption is very clear:

“it is my conviction that if we want to explain economic phenomena at all, we have no means available but to build on the foundations given by the concept of a tendency toward an equilibrium. For it is this concept alone which permits us to explain fundamental phenomena like the determination of prices or incomes, an understanding of which is essential to any explanation of fluctuation of production. If we are to proceed systematically, therefore, we must start with a situation which is already sufficiently explained by the general body of economic theory. And the only situation which satisfies this criterion is the situation in which all available resources are employed.” (Hayek, Prices and Production in Hayek 2008: 225).

"You're wrong to claim that Hayek held the equilibrium state as what a free market would actually reach. "

He certainly did so in Prices and Production. Your error is conflating Hayek's different and conflicting views on equilibrium in the course of his whole career - as though he held some consistent and unified position throughout his entire life. That is false.

Michael Emmett Brady ... has an article comparing and contrasting the approaches to uncertainty taken by F.A. Hayek and John Maynard Keynes.

Thanks for the link. That is a very interesting paper by Brady, and I liked his conclusion:

"Hayek could not accept the standard concept of uncertainty as defined by Keynes, Knight and Schumpeter because it would then beimpossible for market prices to concentrate knowledge that did not exist. In conclusion, nowhere in any of Hayek’s three articles on Knowledge in Economics in 1937, 1945 and 1947 does Hayek deal with the standard view that uncertainty means knowledge that is not there." (p. 15).

His view of Hayek is insightful:

"Keynes, Knight and Schumpeter deny Hayek’s claim that the market generates price vectors which concentrate the knowledge so that savvy, knowledgeable entrepreneurs can act on this information and solve the problem of uncertainty. Uncertainty means vital ,important information is missing. Piecesfrom the puzzle are missing and will not turn up in the future" (p. 14)

On p. 8 he discusses G. L. S. Shackle's break with Hayek over the issue of uncertainty - that makes fascinating reading.

On the subject of uncertainty, I think Paul Davison has made similar criticisms of Hayek before, but I would have to chase up the reference.

"Lord Keynes, is there any way I can contact you besides this blog? "

If you want to leave questions with an email address in a comment here, I will not publish the comment and get back to you by email.